IP Accounting

Category: WTO Sub-category: Intellectual Property
Document type: article

Accounting is the art of assessing the financial information relating to a business entity’s resources and their use in meeting the entity’s goals. It is a service function intended to communicate required information to the operating units and other service functions of an entity. 

As corporations around the world are awakening to the revenue-generating potential of intangible assets, the issue of accounting for intellectual property gains importance. There is hardly any agreement on how these intangible assets should be accounted for, and thus the same company’s balance sheet can vary under different accounting rules. However, this issue is receiving increasing attention from global accounting standard setters. To achieve greater transparency in the financial statements, business entities are being encouraged to reveal information about assets which were previously excluded from their balance sheets. In fact, the Financial Accounting Standards Board (FASB) in the US is seriously considering the inclusion of unrecognised assets in the balance sheet. In fact, most multi national corporations are gradually realising the benefits and importance attached to IP and giving it increased significance in their balance sheets. 

IBM has been an IP-based company ever since 1896, and admits that IP is incredibly important for their business. John Pryor, CPA Global's Vice President for Patent Portfolio Optimisation, feels that over the last 15 to 20 years, intangible assets had formed around 20% of the value of an organisation. But today they account for almost 70% of the balance sheets of companies, around the world. In the Annual Report for year 1999 Nokia had US$11 Billion of tangible asset. However the company owns $183 Billion in intangible assets. Movements in the intangible assets of The Linde Group during the 2008 financial year amounted to 11,603 € million. 

Internationally recognized accounting-standard setting bodies like the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) have identified the difference between the kind of information provided by accounting and the information needed by investors and managers. Current accounting standards, which are strongly influenced by tangible assets, have difficulty in determining the value of IP because of the absence of organized and transparent markets. Following the norm of recording business items at their price, only IP that is licensed or sold can be included in the balance sheet. With such challenges in accurately determining the value of IP, accounting professionals apprehend that disclosing a firm’s IP may be too subjective and hazardous. Moreover, accountants have always been reluctant about anticipating the value of assets or future gains on the balance sheet. 

Different Accounting Standards are being followed in different countries in relation to intellectual property rights. Accounting Standard (AS) 26 came into effect in respect of expenditure incurred on intangible items during accounting periods commencing on or after 1-4-2003 and is mandatory in nature from that date for the following: 

  1. Enterprises whose equity or debt securities are listed on a known stock exchange in India and those in the process of issuing equity or debt securities that will be listed on a recognised stock exchange in India as proved by the board of directors’ resolution in this regard. 
  2. All other commercial, industrial and business reporting enterprises, whose turnover for the     accounting period exceeds Rs. 50 crores. 

This Standard covers all intangible assets except those that are covered by another Accounting Standard, such as financial assets, mineral rights and expenditure, extraction of minerals, oil, natural gas and similar non-regenerative resources and those arising in insurance enterprises from contracts with policy holders. 

International Accounting Standard (IAS) was issued between 1973 and 2001 by the board of the International Accounting Standards Committee (IASC). The IAS 38 became applicable to the accounting of intangible assets from 31st March 2004. It prescribes the accounting treatment for intangible assets that are not dealt with specifically in another Standard. IAS 38 recognises an intangible asset according to specific criteria. This Standard defines the criteria for asset recognition, specifies how carrying amounts should be measured in subsequent periods, and provides guidance on required disclosures. An intangible asset is an identifiable non-monetary asset without physical substance. Intangible assets like brand name or goodwill are not physical in nature. Before implementing this IAS, all intangible assets were listed as an asset in the balance sheet, irrespective of whether they are generated by a company through successful marketing or have been brought by the company from another.

By 2011, India will integrate its accounting system with the rest of the world, by adopting the internationally accepted International Financial Reporting Standards (IFRS), a move already undertaken by more than 109 countries of the world, including China. Many more like Japan, Canada and South Korea are expected to follow suit. Such a common accounting standard is in the interest of the investors who are willing to explore investment opportunities in other parts of the world. The IFRS, which has been formulated by UK-based IASB, will replace the Generally Accepted Accounting Practices (GAAP) in the US.

The appropriate methodology for accounting for business combination has undergone many debates and discussions. IAS 22 permits business combinations to be accounted for, using either the pooling of interest method or the acquisition method. Following the suggestions to eliminate the pooling of interest method, the IASB has issued IFRS 3 Business Combination. Thus, business combinations must be accounted for using the acquisition method which requires the fair value of acquired assets and assumed liabilities and contingent liabilities to be measured at the date of acquisition.

The IFRS 3 supersedes IAS 22 Business Combination and is accompanied by the issue of revised standards of IAS 36 Impairment of Assets and IAS 38 Intangible Assets. It include the identification and valuation of intangible assets and contingent liabilities, determination of appropriate assumption to be used in fulfilling the impairment testing requirements of IAS 36 and the determination of useful lives for intangible assets in accordance with IAS 38. IFRS 3 provides limited guidance on determining fair value. Section V of this publication outlines the most common methodologies for determining fair value and the information required for using those methodologies. IFRS 3 also expands on the disclosure requirements previously included in IAS 22.